Skip to content Skip to footer

Guidance released by the OECD for the impact of COVID-19 on Transfer Pricing

Transfer Pricing
documentation relating to FY 2020 wil l need to be prepared and filed this year. TP and
the arm s length principle are tricky enough concepts but adding COVID 19 and its implications into the
mix will give any head of t ax, g r e y hair . T ypical questions we have heard clients asking includ e

H ow will we demonstrate in future that losses or low profits were not due to any transfer mi s
pricing but rather as a result of the pandemic?

H ow do we justify in future that we put interest charges in relation to the intercompany loan
to our related p arty on hold

S hould we be renegotiating our intercompany related party arrangements based on current
circumstances
Fortunately
in December 2020 , t he OECD provided some g uidance in this regard in its report titled
“Guidance on the transfer pricing impli cations of the COVID 19 pandemic ”. T he stated purpose of the
report was to provide both taxpayers and tax authorities with guidance regarding the application of the
arm s length principle and the OECD transfer pricing guidelines , to issues that may arise o r be
exacerbated in the context of the COVID 19 pandemic
F
our priority issues were identified in the report nam ely:
1)
comparability analysis
2)
losses and the allocation of COVID 19 specific costs
3)
government assistance programs
4) advanced pricing agreements or APA’s.
The OECD clarifies in the report that this COVID-specific guidance does not replace or expand on the
OECD’s transfer pricing guidelines. And, in fact, the OECD has reiterated, through this report, that the
arm’s length principle remains the correct standard to evaluate controlled transactions, even in relation
to the impact of COVID. Throughout the report, significance continues to be given by the OECD to
consideration of the specific facts and circumstances, which should include “accurate delineation” of the
controlled transaction.
Tax administrations are advised in this guidance to consider a pragmatic approach where it is clear that
taxpayers are making bona fide efforts to determine arm’s length prices in the context of a lack of available
information associated with the pandemic. It is therefore important for taxpayers to make reasonable
effort to do this, while remaining flexible and using reasonable commercial judgment, supplemented, as
far as possible, with contemporary information.
The first issue highlighted by the OECD: Comparability
How are we supposed to perform a comparability analysis when, often, particularly when applying the
transactional Net margin method, we are relying on historical data to do these analyses? Financial data
from 2017 – 2019 would not reflect the drastically different financial environment in 2020.
Well, given that contemporaneous uncontrolled information reflects how independent parties are being
affected in a substantially similar economic environment, the OECD proposes that, ideally, businesses
should seek to contemporaneously document how, and to what extent, they have been impacted by the
pandemic. Sources of information which the OECD says could be used includes, amongst others,
– an analysis of changes in sales volumes
– an analysis of changes in capacity utilizations
– quantification of the effects of any government assistance received
– macro-economic information like country-specific GDP data
– a comparison of budgeted and actual costs and results – in other words, what would the
financial outcomes have been but for COVID’s impact?
Obviously, the idea here would be for the taxpayer to be able to prove that the negative financial impact
in 2020 was snot due to Transfer mis-pricing but rather as a consequence of the pandemic.
The guidance also proposes that tax administrations be flexible and pragmatic in their consideration of
the approach followed by a taxpayer to collect data and information for a TP analysis and should, as far
as possible, ensure access to mutual agreement procedure, or MAP, for taxpayers.
Regarding the period of data used to evaluate arm’s length pricing, it is suggested that separate testing
periods be used for the duration of the period in which the material effects of the pandemic were most
evident. But, as with all TP comparability analyses, the type, and the extent to which, adjustments to a
comparability analysis are relevant and required, should be determined on a case-by-case basis. Accurate
delineation of the controlled transactions remains as relevant, and as important, as ever.
The second issue highlighted by the OECD: TP guidance on losses and the allocation of COVID-19 specific costs
The pandemic, classifie
The pandemic, classified by the OECD as a “hazard risk” (which is an external risk which causes damage or d by the OECD as a “hazard risk” (which is an external risk which causes damage or harm if it materializes), has resulted in the materialization of many other risks, such as market risk and harm if it materializes), has resulted in the materialization of many other risks, such as market risk and financial risk.financial risk.
A
As we knows we know,, the allocation of risks between partiethe allocation of risks between parties s is a determining factor in is a determining factor in how profits or losses how profits or losses associated with that specific transactionassociated with that specific transaction,, are allocated at armare allocated at arm’’s lengths length. .
In
In answeranswer toto the question the question “S“Should a limited risk entity incur losseshould a limited risk entity incur losses?”?”, y, yes es — they canthey can, but , but — perper the the OECD OECD TP guidelinesTP guidelines, “, “simple or lsimple or low risk functions are not expected to generate losses for a long period of timeow risk functions are not expected to generate losses for a long period of time””. .
W
When performing a comparability analysishen performing a comparability analysis,, comparablecomparabless selected should be suitableselected should be suitable,, taking taking the risks the risks assumed by the parties to the control transactionassumed by the parties to the control transaction into accountinto account.. OObviobviouslyusly,, a a Limited Risk Distributor Limited Risk Distributor ((““LRDLRD””)) that does not assumethat does not assume,, for examplefor example,, credit riskcredit risk,, should not beshould not bearar the losses derived from the the losses derived from the realization of that credit riskrealization of that credit risk..
A
As regards the question of whether an s regards the question of whether an entityentity should be reshould be re–negotiating its intercompany related party negotiating its intercompany related party arrangementsarrangements…… IIt is important for that entity to consider factors such ast is important for that entity to consider factors such as::

– the the options realistically availableoptions realistically available

– the longthe long–termterm effects on the profit potential of the partieseffects on the profit potential of the parties

– whether whether any party any party should should be indemnified against any harm which could result from the be indemnified against any harm which could result from the renegotiarenegotiationtion

– wwould independent partiesould independent parties,, acting at armacting at arm’’s lengts length andh and under comparable circumstancesunder comparable circumstances,, consider reconsider re–negotiation of contractsnegotiation of contracts..
A
An interesting point is made in the gn interesting point is made in the guidanceuidance around the around the incurralincurral of operaof operating costs ting costs due todue to the pandemicthe pandemic — such as expenditure on personal protective equipment and expenses spent on the reconfiguration of such as expenditure on personal protective equipment and expenses spent on the reconfiguration of workspaces to enable physical distancingworkspaces to enable physical distancing..
F
For those costs that are deemed to be or those costs that are deemed to be ““exceptionalexceptional”” or or ““nonnon–recurringrecurring”,”, thethey would generally be excluded y would generally be excluded from the net profit indicator relating to the controlfrom the net profit indicator relating to the controlledled transactiontransaction.. HHoweverowever,, the point made by the OECD the point made by the OECD in this regard is that certain of these costs may not be viewed as in this regard is that certain of these costs may not be viewed as ““exceptionalexceptional”” or or ““nonnon–recurringrecurring”” if thif thoseose costs relatcosts relate to longe to long–term or permanent changes in the business operationsterm or permanent changes in the business operations..
The third issue highlighted: TP guidance on government assistance programs
W
What is hat is ““government assistancegovernment assistance”” in this context?in this context? TThe he guidanceguidance states that government assistance is a states that government assistance is a monetary or nonmonetary or non–monetary program in terms of which a government provides a direct or indirect monetary program in terms of which a government provides a direct or indirect economic benefit to eligible taxpayerseconomic benefit to eligible taxpayers. T. This can be in the form of grantshis can be in the form of grants,, tax deductionstax deductions,, etcetc..
T
To be considered in the coo be considered in the context of ntext of COVID, COVID, and specifically and specifically — whether the receipt of such government whether the receipt of such government assistance would be translated inassistance would be translated into anto an entitentity’sy’s pricing strategypricing strategy — is the extent to which the receipt of such is the extent to which the receipt of such government assistance is an economically relevant characteristic with regovernment assistance is an economically relevant characteristic with respect to the control transactionspect to the control transaction. . OObviouslybviously,, if it is determined to be an economically relevant characteristicif it is determined to be an economically relevant characteristic,, this information should be this information should be included in the documentincluded in the documentationation prepared to support the TP analysisprepared to support the TP analysis..
A
Also important to consider would be lso important to consider would be ––

– which partywhich party is allocated the economicallyis allocated the economically significant riskssignificant risks

– the impact of the pandemic on the outcome of those economically significant risksthe impact of the pandemic on the outcome of those economically significant risks andand

– the impact of any government assistance on the mitigation of the risks materializingthe impact of any government assistance on the mitigation of the risks materializing..
Further,
Further, the receipt of governmenthe receipt of government assistance may be seen t assistance may be seen to beto be a local market featurea local market feature — in which case in which case the current OECD the current OECD guidanceguidance regarding local market features would remain applicableregarding local market features would remain applicable..
The fourth issue highlighted: APA’s
T
The final issue addressed in the ghe final issue addressed in the guidanceuidance by the OECD relates to advance pricing agreementsby the OECD relates to advance pricing agreements, or, or APAPA’s. A’s. TheThe Guidance reaffirms that APA’s are useful instruments to ensure tax certainty. It goes on to say that Guidance reaffirms that APA’s are useful instruments to ensure tax certainty. It goes on to say that eexisting APxisting APA’sA’s cannot be automatically disregarded cannot be automatically disregarded based onbased on changes in economic circumstanceschanges in economic circumstances — and and this is true for both taxpayers as well as tax authorithis is true for both taxpayers as well as tax authoritiesties. A. Any determination of a breach in a critical ny determination of a breach in a critical assumption should be analyzed on a caseassumption should be analyzed on a case–byby–case basiscase basis. I. In the absence of applicable domestic law in this n the absence of applicable domestic law in this regardregard,, such a breach in a critical assumption could have three potential outcomessuch a breach in a critical assumption could have three potential outcomes,, namelynamely,, revision revision of of the the APA, APA, cancellation of the cancellation of the APA, orAPA, or revocationrevocation of the APA in cases where a of the APA in cases where a taxpayertaxpayer’’s neglects neglect,, carelessness or willful default resulcarelessness or willful default resultsts in a misrepresentationin a misrepresentation,, mistake or mistake or oomissionmission,, oor wherer where a taxpayer a taxpayer fails to comply with fails to comply with aa material term or condition of material term or condition of the Athe APAPA..
T
Taxpayers and tax authorities alaxpayers and tax authorities aliikkee need to be innovative and flexible to ensure collaborative working need to be innovative and flexible to ensure collaborative working when it comes to negotiating APwhen it comes to negotiating APA’s.A’s.
The key takeaways from this report
In my view, the key
In my view, the key takeaway is that companies will need to put in a substantial amount of effort into takeaway is that companies will need to put in a substantial amount of effort into documenting the effect of the pandemic on their operatiodocumenting the effect of the pandemic on their operationns, documenting their Transfer Pricing policies s, documenting their Transfer Pricing policies applied in 2020 applied in 2020 –– including changes to those policiesincluding changes to those policies, and why they b, and why they believe that their actions in 2020 were elieve that their actions in 2020 were warranted and in accordance with the arm’s length principle.warranted and in accordance with the arm’s length principle.